I am a Professor of Economics at Texas Christian University, where I have worked since 1987. My areas of specialty are international economics (particularly exchange rates), macroeconomics, history of economics, and contemporary schools of thought. During my time in Fort Worth, I have served as department chair, Executive Director of the International Confederation of Associations for Pluralism in Economics, a member of the board of directors of the Association for Evolutionary Economics, and a member of the editorial boards of the American Review of Political Economy, the Critique of Political Economy, the Encyclopedia of Political Economy, the Journal of Economics Issues, and the Social Science Journal. My research consists of over thirty refereed publications, two edited volumes, and one book (with another in process). I have also been lucky enough to win a couple of teaching awards.
In terms of my approach to this blog, I am a firm believer that economics can and must be made understandable to the general public, but that our discipline has done a very poor job in this regard. This is particularly true of macro issues, where people quite naturally assume that their personal experiences are analogous to those at the national scale. Very often, this is not the case, with the result that politicians and voters (and some economists) press for policies whose effects are quite the opposite of what was intended. That this is problematic has never been more evident than today. I also try to steer as clear of politics as possible. I want to explain how things work, not what you should believe.
I have been married to my wife, Melanie, for over twenty-five years, and we have twin daughters (who have just started college) and a dog named Rommel (who has not). My favorite pastimes are online computer gaming and reading about WWII history.

Why You Should Learn to Love the Deficit: Federal Budget Fallacies

I’ve made eleven contributions to Forbes.com so far, over half of which were aimed directly at correcting misconceptions regarding the debt and deficit. Nothing could be more foolish right now than policies that reduce government spending or increase taxes. We have nearly 14 million unemployed people in the United States, a number that undoubtedly underestimates the true magnitude of the problem since it ignores discouraged workers and the underemployed. Despite this, Messrs. Obama, Ryan, and Geithner tell us that we need to make sacrifices. Seriously? The American people already have, and what they are asking us to do will simply make it worse.

And so, I’m writing on this issue yet again. There won’t be anything new here, but I want to organize it in a slightly different manner. I’ll begin with a very general background, then offer a list of popular fallacies, and close with some pointers to more resources.

BACKDROP

Understanding the role of the federal budget requires knowing a little something about the macroeconomy. Most critical is the fact that the private sector is incapable of consistently generating sufficient demand to hire all those willing to work. This is in spite of being able to produce enough output for everyone to enjoy–in fact, it’s partly because of it. A detailed explanation is offered in this post, Why Recessions Happen, but for here suffice it to say that if 90 people can produce a sufficient volume of goods and services to satisfy 100 people, then why would the private sector hire all 100? It wouldn’t, and those without jobs must go without the output that we are nevertheless able to produce for them. The unemployed lack the income that would make the production of those extra goods and services profitable.

This is where the government can play a useful, indeed vital, role. They can supplement demand by employing the unemployed as soldiers, sailors, airmen, marines, teachers, firemen, police officers, etc. Because we started at a point of less-than-full capacity, private sector workers give up nothing, entrepreneurs earn extra profits, and it creates a series of non-market services (national defense, fire protection, education, etc.). It is truly a win-win situation, which is possible when we have idle resources. And the funds to finance these activities should come from deficit spending. There is no point in taxing away spending power from the private sector in order to create demand from the government. That’s self-defeating.

This is the essential role that only the government can play, for only it can create demand from thin air. There is no other alternative if we want capitalism to survive. Should we seek to limit government power? Absolutely, just as much as we should do so with those mega-corporations that are dominating the private sector. But a modern capitalist economy without public sector demand will fail.

POPULAR FALLACIES (in no particular order)

When the government spends in deficit, that means I am being taxed more: I’ve heard this one numerous times and it’s very obviously false–the fact that you are not being taxed to cover the spending is WHY it’s a deficit! If taxes were rising along with the spending, then it would be a balanced budget. Does it mean taxes may rise in the future? It shouldn’t. In fact, if the deficit does what it’s supposed to, then the economy grows and the deficit automatically shrinks (as tax revenues rise and government spending for unemployment and income assistance falls).

Cutting the deficit by reducing spending puts money in my pocket: This ignores the fact that a) you weren’t being taxed to finance the deficit in the first place (or it wouldn’t have been a deficit) and b) government spending is money in someone’s pocket. Thus, cutting the deficit by reducing spending removes money. This is true even if you are in the private sector, since those government employees bought groceries, paid rent, went to the mall, etc., etc. They earned income for you by buying what you sell.

You can’t spend your way out of a recession: Of course you can. We did it in the Great Depression, Reagan did it, and it’s what we should be doing right now (instead of bailing out the financial industry, wasting time with Quantitative Easing, and trying to balance the budget). Why this works should be obvious from the backdrop offered above. Businesses will regain confidence, consumers will spend, and banks will loan. So, yes, you can spend your way out of a recession because a recession is caused by lack of spending.

Cutting government spending frees up resources for the private sector to grow: It might do so if we were already at full employment and using all our productive capacity. However, in the midst of the worst recession since the Great Depression, this argument holds no water whatsoever. We have plenty of idle resources, the private sector is simply choosing not to employ them. There is no need to free up something that is already in excess supply. Nor is there some web of regulations and taxes that is preventing recovery. The past thirty years has been a continuous deregulation of our economy and effective tax rates as a low as they have been since before World War Two.

The debt has never been this large: The proper measure of the size of the debt is relative to the size of the economy. Gross Domestic Product is typically used as the gauge of the latter. Even the most extreme measures of where it stands today puts debt/GDP at less than 100%. It reached it peak during WWII, when it was around 120% of GDP. The 1950s were , incidentally, hardly a period of economic Armageddon.

We have largest debt in the world: According to the CIA Factbook, as of 2010 we ranked 37th. That put us behind the world average, Spain, The Netherlands, Austria, the UK, Israel, Germany, Portugal, France, Ireland, Belgium, and Japan.

The debt must be repaid: We must, of course, meet the “monthly payments,” but the level of debt need never be zero. The government has an infinite life span, so there is no day of reckoning when all debts must be settled. And since the debt is owed in dollars, there is never any question that we have the ability to repay since we are allowed to issue brand new ones at any time. Nor is this necessarily inflationary, as explained in the next fallacy.

Deficit spending could create inflation: Yes, it could, if we were already at full employment (unemployment around 4%). In that case, the government would be competing for resources in an economy where no excess existed–that might drive up prices. But we are a long, long way from that right now. Furthermore, inflation is a far more complex phenomenon than most people understand. For more on how inflation really works, see here:

Government surpluses help the economy grow: In fact, surpluses represent a net drain on private-sector income. Think about it: what would happen if the government spent zero but still collected taxes? That’s what a surplus is, an excess of tax revenues over government spending. We would be bleeding wealth from the private sector and giving it to the public sector. Economic growth creates government surpluses (because tax revenues rise and public support spending falls), not the other way around.

The US could default: Every penny of US debt is owed in a currency we are legally permitted to print. There is ZERO chance that we could be forced to default. We may choose to do so (just as a person in a room full of food could choose to starve), but that would be foolish. Note the strong contrast with Greece. They could, indeed, default, since they owe their debt in a currency they don’t control (there are, incidentally, many other reasons why the US and Greece are not analogous, but this one is key).

Quantitative Easing represented government deficit spending: These two are fundamentally different. Deficit spending creates new income by having the government pay for goods, services, and resources using the Treasury Department’s checkbook. Quantitative easing was meant change the form in which financial assets were held in the banking system so that it would easier for institutions to loan money. It created absolutely no new income whatsoever, which is why it was an utter waste of time. The problem was never that banks didn’t have money to loan. It was (and is) that everyone is too scared to borrow.

China controls our economy because we owe them so much money: It must be made clear that US debt to China has nothing to do with the federal government budget deficit and everything to do with the trade deficit. Even if the US government were in surplus, we would owe as much to China because our debt to them is simply the difference between how much we exported to them and how much we imported from them. They then take those excess earnings and use them to buy financial assets. That we had large budget deficits only served to make a particular financial asset–Treasury Bills–available to them in large quantities. We never needed China to buy these to finance the deficit because (in a roundabout fashion) we could always have monetized debt (i.e., sold the Treasury Bills to the Federal Reserve for brand new cash–see above for why this is not inflationary). The one thing we still don’t import from China are dollar bills! If they wanted all the money back tomorrow, we could just print it up and ship it over. China does not own the US, and they desperately need us to grow if they are going to make it because they have very little domestic demand to generate growth and are dangerously dependent on exports.

FURTHER RESOURCES

Explaining all this is so difficult because people already have in their heads that government budgets are analogous to their own. This is false, but it takes time and patience to explain why. Thus, while I hope you found the above interesting, you may want to read these, too. They represent more pointed and extended discussions of the issues we face.

This is the first piece I wrote here and is the most comprehensive treatment I have done:

I’d like to apologize in advance for the fact that I am simply not going to have the time to devote to answering comments that I usually do. I’ll do my best, but I have to start being more selective. I have too many other obligations, not least of all to my family! Speaking of which, I would also like to take this opportunity to publicly thank my wife, Melanie, for her help, encouragement, and patience with this project. She has read over many of these entries for me, pointing out where I was wrong and when I was unclear. Thanks, babe.

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Comments

Good article. It’s good to see rational information being presented. When I was growing up the highest tax bracket was over 90%.

Increased productivity has caused a reduction in demand for labor. We don’t currently have a replacement for manufacturing jobs. This problem was already obvious in the 50s. The plan was to reduce work hours to get more people participating in the work force. Like many good plans that one just faded away. Improvements in automation and robotics will further reduce employment. Our species is at it’s best when we are expanding. Unfortunately that kind of expansion won’t be available again until we get to other planets.

Your making the same mistake the entire mainstream economic profession has made by not understanding the nature of monetary operations. Once you follow the money. You’ll realize the federal government, as the currency issuer, is the monopoly producer, lender, and price setter of money. Once you wrap your head around that notion and what that exactly means things will slowly come into perspective for you. Don’t feel bad for not grasping these things all at once. Einstein discovered the law of relativity and he still couldn’t get his mind around quantum physics…and he was Einstein!

• All this deficit spending may be risky for the U.S. economy, however, the trillions of dollars in debt the Democrats are racking up will make Barack Hussein Obama tremendously popular at re-election time. The Democrats are buying people cars, health care, buying car companies and winning lots of friedns with the unions and company mgnt, handing out trllions of dollars in deficit spending, nice raises in pay for the soldiers in the military, tons of money for local school boards to win over the teachers, etc.. etc… Now think about someone such as Gov. Palin. Gov Palin wants to balance the federal budget. In the process, it will be like taking away a child’s allowance. Hence, I predict Barack Hussein Obama will easily win re-election before while placing the US$ on the same path as Aregentinian Peso.

“We never needed China to buy these to finance the deficit because (in a roundabout fashion) we could always have monetized debt (i.e., sold the Treasury Bills to the Federal Reserve for brand new cash–see above for why this is not inflationary).”

Under current law this is not possible. The Fed cannot provide an “overdraft” to the Treasury and they cannot directly buy Treasuries from them. The treasuries must issue them through primary dealers in the auction format.

It is a shame that we have so many people in this country that never question the absolute BS that politicians are always spouting. Such pronouncements as “everybody knows you don’t raise taxes in a recession” and “raising taxes takes money that could be invested away from the economy”. I know why such things could be said under the right conditions as you pointed out in the article.

I guess it bothers me that so many of our fellow citizens get their news and views from lying dog politicians. Those guys have been around long enough to know many of these comments false or incorrect, but dumbasses abound and far too many listen to a politician tell them how the economy works rather than an economist. Even supply side economists know that a couple of trillion held by private sector businesses says there is no place to invest. My only question is why more economists don’t call these lying dogs out in public. They really need to be harassed in the forum where they make these kinds of statements.

groupthink is the problem. the mainstream economic profession is defined by 6 schools and the different camps really don’t acknowledge each other. John, the author, subscribes to the Kansas City school of economic thought. I’m putting together a sight that explains this mess for the laymen. – DollarMonopoly.com

It’s interesting that you bring up what I call the Paradox of Productivity – the better you are at making stuff the less people you need which means that there is less people to buy the stuff you are making.

However there is one other solution to the Paradox which is to try and get the external sector to fill the gap left by the domestic sector.

That is the solution attempted by the Germans, and it has been very successful because they managed to persuade a load of other countries to peg their currency to them.

So the Euro crisis is really a crisis of consumption in the German economy, which the Germans can then export to others due to the currency peg.

Obviously the author hasn’t read (or at least understood) Adam Smith’s “An Inquiry Into the Nature and Causes of the Wealth of Nations”. There Adam Smith explained why government spending doesn’t help the economy, and in fact is a drag: it pulls people away from productive work. The main causes of unemployment: 1) People get paid not to work. Long-term unemployment payments (and welfare) is a disaster. The government gets what it pays for: people not working. 2) Obamacare and fear of tax hikes (due to the large deficit) make employers nervous about hiring due to the expectation of increased benefit costs. 3) Reduced foreign capital investment, as the federal reserve’s gratuitous money-printing drove away foreign investors. Private-sector capital investment drives productive job growth. 4) A high minimum wage, which discourages hiring of unskilled workers who need to learn skills to obtain better jobs. 5) Laws that prevent employers from hiring any willing worker, and apparently in the case of Boeing, preventing them from building new factories. There would be plenty of manufacturing jobs available if there weren’t union restrictions on productivity, continuous employment (strikes to make the union leadership seem important), benefits, and wages.

Finally, there is not a finite number of jobs available: there is a shortage of competent people in software, some areas of healthcare, and many types of research and development, all of which could soak up a virtually unlimited number of people in productive activities that grow the economy. People would learn new skills to fill these positions if they had sufficient financial motivation to go to school and obtain the required skills. Software in particular is not terribly difficult to learn, as long as people are motivated and disciplined.

Keynesian Economics depends on ideas Adam Smith disproved 200 years ago, and seems to be used mostly as an excuse to support political corruption. Monetarism was discredited through multiple examples by Adam Smith, yet the Federal Reserve still practices it. These false ideologies have led to actions greatly damaging to the economy.

FDR’s command economy turned a severe cyclical panic, of the type that occurs every 20 years or so, into the worst depression in US history. Government overspending there didn’t solve anything; it made it worse. If Keynesian Economics were true, then the economy should have been booming well before 1938, not stuck in recession.